Employers frequently offer various benefits to retain existing employees and attract new talent. Among these incentives, equity-based compensation—granted in the form of company shares—is quite common. These shares are typically offered as either RSUs or ESOPs. For salaried professionals, understanding these options is essential to maximize their potential value.
What is an ESOP?
An Employee Stock Option Plan (ESOP) is a scheme that allows a company to reward its employees by offering them the opportunity to purchase company shares at a set price on a future date.
When ESOPs are granted, the shares aren’t given to the employee right away. Instead, they’re held in a trust for a specified period called the vesting period. After this period ends—on what is known as the vesting date—the employee gains the option to buy the shares at the predetermined price.
Example of ESOP
Consider this scenario: Company S Ltd. granted 200 company shares to its employee, Mahesh, on 20th April 2020. These shares came with a vesting period of three years, meaning Mahesh had the option to purchase them starting 21st April 2023.
If on that date, the market price of the shares exceeds the predetermined purchase price, Mahesh can exercise his option and buy the shares, potentially gaining from the price difference. However, if the market price is lower than the offer price, exercising the option wouldn’t be beneficial. In such a situation, Mahesh can choose not to proceed with the ESOP.
What is an RSU?
Restricted Stock Units (RSUs) are another type of employee benefit offered by companies. RSUs represent a commitment from the employer to provide a certain number of company shares—free of cost—after the employee completes the vesting period, subject to specific conditions.
Although RSUs are granted at no cost to the employee, they come with some limitations:
- Time-based restrictions: Employees can only sell these shares after completing a required period of service. If the employee leaves before the vesting period ends, the employer may cancel the RSUs.
- Milestone-based restrictions: These depend on performance or specific goals. Employees receive the shares only after achieving set targets.
- Composite restrictions: This combines both time-based and milestone-based conditions. The employee must meet both the service duration and the performance criteria to gain ownership of the shares.
Difference Between ESOP and RSU
| Aspect | ESOP (Employee Stock Option Plan) | RSU (Restricted Stock Units) |
| Incentive Control | Employees have the choice to exercise or skip the option to buy shares. | Shares are automatically awarded at the end of the vesting period. |
| Impact of Market Price | Market price is a key factor in deciding whether to purchase the shares. | Market value only affects the tax calculation, not the decision to accept shares. |
| Earning Potential | Offers higher returns if the company performs well and share prices rise. | Gains are limited to the stock’s value at the time of vesting. |
| Employee Contribution | Employees must pay a fixed price to acquire the shares. | No payment is required; shares are given at no cost. |
| Preferred By | Commonly used by early-stage start-ups and fast-growing businesses. | Favored by large, established, and mature companies. |
RSU vs ESOP: Taxation Explained
Both RSUs and ESOPs are considered taxable perquisites, but the timing of taxation differs. In the case of ESOPs, tax is applicable when the employee exercises the option to buy the shares. For RSUs, taxation is triggered when the shares are actually received by the employee.
At the time of receipt, the employer deducts TDS based on the perquisite value, which is calculated as the difference between the fair market value (FMV) of the shares and the amount paid by the employee. Since RSUs are granted free of cost, the entire FMV is treated as a taxable perquisite.
Later, when the employee sells these shares, capital gains tax becomes applicable. Both ESOPs and RSUs follow the same rules under capital gains taxation.
Capital Gains Tax Treatment
| Category | Shares Listed on Indian Stock Exchange | Shares Not Listed on Indian Stock Exchange |
| Short-term Capital Gains | If held for less than 12 months: taxed at 20% | If held for less than 24 months: taxed as per the employee’s income tax slab |
| Long-term Capital Gains | If held for more than 12 months: taxed at 12.5% | If held for more than 24 months: taxed at 20% |
| Exemption | Exemption up to ₹1.25 lakh for LTCG | No exemption available |
| Indexation | Not applicable | Not applicable |
Note: As per Budget 2024, the indexation benefit has been removed for long-term gains on unlisted equity shares.
RSU vs ESOP – Which One is Better?
Having explored the key distinctions between RSUs and ESOPs, it’s clear that both serve as employee incentives offering future ownership in the company. While both grant shareholding benefits, the main differentiator lies in the cost to the employee. With ESOPs, employees are required to pay to acquire the shares, whereas RSUs are granted free of charge.
This makes ESOPs inherently riskier—there’s always the chance the share price may drop below the purchase price, leading to a potential loss. In contrast, RSUs involve no financial outlay, and the only real risk is if the company fails entirely, which is rare.
In most cases, RSUs offer a safer and more reliable benefit than ESOPs. The primary advantage of ESOPs is the opportunity to buy shares below market value, but only if the market price is higher on the date of exercise.
Final Thoughts
It’s important to note that employers usually don’t provide both RSUs and ESOPs to the same employee. Therefore, you likely won’t have the option to choose between the two. Regardless of the type, both are designed to motivate employees and offer long-term value.
Frequently Asked Questions (FAQs)
1. Are RSUs and ESOPs taxed differently in India?
Yes, the timing of taxation is different. ESOPs are taxed when the employee exercises the option to buy the shares, while RSUs are taxed when the shares are allotted. Both are considered perquisites and taxed as part of salary income.
2. Do employees have to pay anything for RSUs or ESOPs?
For ESOPs, employees must pay a pre-agreed price to buy the shares. RSUs, on the other hand, are granted free of cost at the end of the vesting period, subject to conditions.
3. When is capital gains tax applicable on RSUs and ESOPs?
Capital gains tax applies when the employee sells the shares. The tax depends on how long the shares were held after allotment and whether they were listed on an Indian stock exchange.
4. Which is better: RSU or ESOP?
RSUs are generally considered safer because they don’t require the employee to pay for the shares upfront. ESOPs can offer higher returns if the company performs well, but they come with a financial risk.
5. Can I receive both RSUs and ESOPs from my employer?
In most cases, companies offer either RSUs or ESOPs—not both. The choice usually depends on the company’s stage of growth and compensation policy.
6. How is the perquisite value calculated for RSUs and ESOPs?
The perquisite value is the fair market value (FMV) of the shares on the date of allotment minus the price paid by the employee. For RSUs, the full FMV is taxable since they are granted free of cost.
7. Is there any exemption available on capital gains from RSUs or ESOPs?
For shares listed on Indian stock exchanges, long-term capital gains (LTCG) are exempt up to ₹1.25 lakh per financial year. No such exemption applies to unlisted shares.
